NBS’s Toth: Short Term Boost From Low Inflation (Exclusive)

The current low-inflation environment gives the Slovak economy a short-term boost as an outright deflationary spiral is not expected, National Bank of Slovakia Vice-Governor Jan Toth said in an interview for World Business Press Online.

The National Bank of Slovakia (NBS) on Tuesday slightly raised its economic growth outlook for this year, but again lowered its inflation predictions, pointing to lower oil prices and slower price growth in the services sector.

The NBS now expects the Slovak economy to expand by 3.3% of GDP this year, up by ten basis points from its third-quarter prediction. However, for the next two years, the GDP predictions were revised down – to 3.1% and 3.2% expansion, down by thirty and ten basis points, respectively. The reasons behind this slowdown are the expected deceleration in the EU funding finances program and weaker exports.

Regarding the inflation outlook, the central bank left its HICP prediction for this year intact at minus 0.3%. Again, for the next two years, the predictions were revised down to 0.7% and 1.7%, down by 30 and 20 basis points, respectively.

World Business Press Online (WBP Online) spoke on the sidelines of the press conference with Vice-Governor Jan Toth about the challenges for the Slovak economy.

WBP Online: Where do you see the main sources of growth in the Slovak economy and what are the main changes in the central bank’s fourth-quarter prognosis when compared to the previous one?

Jan Toth: Growth in Slovakia remains well-balanced and both domestic consumption and export continue to support this. However, the overall structure has recently leaned a bit towards domestic consumption, as the economy benefits from the low-inflationary environment. This leads to higher consumption in both households and the public sector, but also to increased investment due to low oil prices and loosened monetary policy of the European Central Bank (ECB).

On the other hand, export growth has slowed down somewhat on the back of lower external demand for Slovak goods, mainly because of the difficult situation in emerging markets.

– What is the relation between the inflationary development and the overall economic conditions in Slovakia and the rest of the euro zone?

Currently, the story is more or less similar. Low oil prices boost both Slovakia and the euro area in the form of stronger domestic demand and household consumption. Also, there have been labor market surprises on the upside in both Slovakia and the wider bloc as firmer consumption creates a better environment for job creation, especially in services.

Regarding the price growth, the link is even stronger as inflation in Slovakia is de facto imported from the currency bloc, so it tends to affect prices of tradable goods more heavily.

So if the ECB forecasts the bloc’s inflation to gradually grow over time – especially in 2017 – the growth trajectory in Slovakia will be very similar.

– You said that the Slovak economy actually gains from the low-inflationary environment. Have you observed any negative signals stemming from this trend, namely in postponed household consumption in anticipation of even lower prices in the future?

What we expect is a zero- or low-inflation environment, not an outright deflationary spiral, where the scenario you outlined may occur. If inflation sinks unexpectedly, if it comes as a surprise, the near-term effect is positive and strong. That’s especially true when talking about real wages, as one negotiates his or her future wages in anticipation of higher price growth, but inflation grows slower than expected.

However, these near-term positive effects would evaporate if prices were actually falling, or an outright deflationary spiral occurred.

So far, however, the effects of low inflation have been positive, mainly through firmer consumption and higher real income.

– What do you expect to happen when the Federal Reserve (Fed) raises interest rates next week? How is this going to affect the Slovak economy, the Slovak inflation outlook and the euro exchange rate?

If the [Fed’s] action was different than expected, if it caused turmoil on financial markets, especially in emerging markets – given their higher private debt held in US dollars – it would be a negative risk. This would spill over into the Slovak economy though the channel of lower demand for our goods. So if the situation got more complicated in China or, say, Latin America – although this region is less important for Slovakia (China is of a much higher importance), Slovakia would feel it in weaker exports.

Speaking about the euro, its lower strength against non-dollar currencies tends to have a positive impact on the Slovak economy as it boosts exports. Regarding the EUR/USD exchange rate, the case is more complicated because the euro’s depreciation in this pair makes energies more expensive, so the effect does not necessarily have to be positive.

At the same time, however, if the euro weakens against the dollar it usually softens versus other currencies as well – even though the effect may not be as stark. So it [the euro depreciation] tends to have positive impact on the economy in general.

– ECB Executive Board member Benoit Coure in a speech delivered at Berkeley Universityopenly urged the world’s academic community to help discover new ways on how to face the current economic challenges and how to redefine new non-standard monetary policy tools. How relevant is that for the National Bank of Slovakia?

I would like to refrain from commenting on the ECB specifically. But speaking about monetary policies in general, strong academic consensus – or let’s say semi-consensus – says that the first step in deploying non-standard measures should always be to use the channel of short-tem interest rates as much as possible. The examples of Sweden, Denmark and Switzerland show us that the limit is not zero, but negative rates below that.

The second recommendation in this approach would be to use forward guidance – a credible one – where the central banks would allow the inflation rate to temporarily miss the targeted levels by behaving laxer than expected. This scenario would loosen up conditions without putting central banks’ balance sheets under pressure.

Outright quantitative easing would be the third step in this approach.

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